Japan one year on – an economic analysis (ii)

This is the second post on how the economic theory of what should have happened in the year following the March 11 earthquake and tsunami matches up with the reality of what actually happened to the Japanese economy.

Economic Growth

Theory - Macroeconomic theory would suggest that following March 11 the Japanese economy would be hit by the double impact of a fall in aggregate demand (AD) and aggregate supply (AS). This should lead to a quite heavy fall in GDP.

Initially AS would have have fallen through a combination of a decrease in production capability, damage to infrastructure and an increase in the costs of production as producers had to quickly import goods normally provided by domestic firms. We would also expect AD to decrease quite substantially, mostly due to the fall in consumption, investment and exports. These falls should be slightly offset by increases in government spending. However, in Japan, consumption, investment and exports make up approximately 75% of the total AD, so any increases in government spending, no matter how substantial, would probably not be able to overturn the overall fall in AD. Interestingly, many students argue that in the weeks after the earthquake AD might have actually increased, as consumers rushed to shops to purchase survival equipment and long-lasting foods such as noodles. This is a good point, and sales and output of those items almost certainly have increased. However, we should consider that there would also have been many other normal goods whose sales would have plummeted, such as fresh foods. The overall effect would probably have been a fall in consumption. Indeed, below is a picture I took one week after the earthquake during rush hour in Yokohama Station. As you’ll know, normally this concourse would be heavily crowded with shoppers and commuters.

Both the fall in AS and AD should be just short term though. As the country gets back on its feet we would expect to see both AD and AS increase, leading to an improvement in GDP. In other words, we would expect the Japanese economy to shrink for one or two quarters after March 11 but to slowly start to recover thereafter, even taking into consideration the exchange rate influences identified in the previous post.

Reality - The graph below shows Japan’s GDP performance over the last year. You can see that the two quarters following March 11 did see the economy shrink, followed by an improvement, as we would have expected. However, what has caught many by surprise is the double dip effect when the GDP fell again in the 4th quarter of the 2011. This could be for a number of reasonsincluding these: the high value of the yen and the Thai floods impacting car manufacturing, and the continuing sluggish performance of the world economy impacting domestic and export consumption. We would expect Japan to bounce back from this and see GDP improve again in 2012, especially if the yen continues to weaken.

About Adam Seldis

Teacher of Economics, History and ToK, Head of Social Sciences and Global Citizen Diploma Coordinator at Yokohama International School, Japan.